MARKET MICROSTRUCTURE

The nondisclosure agreements have lapsed. The Chicago to New Jersey microwave arms race has converged to a few winners. Many of the early participants must now be eying the runaway success (and the glaring shortcomings) of a certain HFT-associated bestseller, and thinking, yeah, “I could do that.”

It’s a fantastic story, after all, and it hasn’t really been told yet. It seems like there are two basic approaches. You could write a cinema-ready page-turner heavy on the skulduggery. Antennas knocked out of alignment the night before the jobs number. Unlicensed broadcasting on cognitive radio. Itinerant con men peddling futures on networks that will never exist. Or you could try to write a book with longer-term importance that draws the details within the larger context and paradoxes of the modern-day United States.

*

A colleague in the tech industry was recently recalling his first encounters with the real Flash Boys.

“It was some time in the summer of 2010 when the calls started coming in,” he said, “It came on suddenly, and then it ramped up. Fast. All through the fall and then into 2011. They’d come on site, and it was clear they weren’t your traditional telecom guys. They were a lot younger, for one. Sandals, cargo shorts, T-shirts. They flat-out refused to say what it was they were actually doing.

“They talked gain margins, modulation, propagation physics, et cetera, but in an oddly theoretical way. It was as if they’d just stayed up late mastering a textbook. Every single one of them wanted to know about regeneration latency. Up to then I’d never given any consideration to internal latencies. Normally, on the digital signal processing side, you’re interested in error correction, and doing it absolutely as well as you can. Extra microseconds had never mattered, period.

“They weren’t staying at the Super Eight. They’d limo out, keep the limo waiting all day. Once, I said to one of them, ‘Hey, let me give you a lift back to the airport.’ Turned out he wasn’t flying commercial. I dropped him off at general aviation. I saw that a G4 was waiting on the tarmac.”

*

In early 2011, I attended an event, known as a research “Jamboree” where everyone – that is, the large collection of physicists working in the building – stands up in rapid succession and gives a one-minute talk while showing pre-loaded PowerPoint slides. Having already given several of these talks, I knew that my previous modus operandi, which had consisted of earnestly trying to explain too much research, and then getting unceremoniously cut off, Gong Show style, was completely ineffective.

When my minute came up, I went up to the podium. My slide was a screenshot of a maze of numbers; an asof joined kdb+ table of equity quotes – sample data that I had been using while learning the terse Q language.

“One minute isn’t very much time,” I said, finally, breaking the silence, “but it’s an eternity in the highly secretive, highly profitable world of high-frequency trading.”

I pointed to the numbers on the slide. “This is a time series of offers to buy and sell shares of stock. What’s completely amazing is that the data structure holding these ticks has a nanosecond field. Every one of the 23,400 seconds in the trading day is now potentially divisible into a billion individual increments. Kind of staggering when you compare with the fact that Earth is 4.5 billion years old.”

“A decade ago, talking about nanosecond stamps on the trade blotter would have been absurd. In the Dot-Com boom, you had day traders flipping shares of Xilinx, and sometimes they even managed consistent profitability. The fastest human reaction times are of order one hundred and fifty million nanoseconds.”

“Speed of light is a foot per nanosecond. Einstein’s theory of special relativity is now an economic issue. A few more orders of magnitude decrease in latency, and general relativistic time dilation starts to matter. In the future, to get a competitive interest rate, you’ll need to live deep in a gravitational potential well, and you’ll need to have your bank out in flat space time.”

My minute was up. Everyone was staring at me like I’d arrived from outer space.

“Well, Uh, OK…” the moderator said, “That was something different. Our next speaker is going to tell us about the accretion of gas onto galaxies at redshift Z=2.”

*

The next day, I ran into a colleague, I’ll call him Tim, in the hallway, “Were you serious?” he asked.

“More or less,” I said, “General Relativity – gravitational time dilation – that’s for sure playing no role in the market right now, but special relativity is relevant in the sense that the distinction between timelike and spacelike events definitely matters if you are back-testing a strategy against historical data.”

I told him about the scheme to use a microwave relay to beat Spread’s Network. “Apparently, they spent of order $300M to trench the fiber. Wireless could be more than two orders of magnitude less expensive…”

“I’m in,” he said.

*

Even at 1% the expense of Spread’s fiber, a clandestine wireless relay spanning a third of the continent presents a daunting project. The urgent question at the start of 2011 was whether anyone had gotten there first.

The geodesic arc from Chicago to New York never strays far from 41 N, and the FCC has made it easy to query for entities that fit specified criteria within a relevant geographic range. A first pass through the filters produced a jumble of familiar and obscure names:

AB Services LLC

airBand Communications

AT&T Corp

Cellco Partnership

Clearwise Spectrum Holdings II & III, LLC

Comprehensive Wireless, LLC

ECHOSTAR CORPORATION

FELHC, Inc.

FiberTower Network Services Corp.

FiberTower Spectrum Holdings LLC

Fundamental Broadcasting LLC

HISPANIC INFORMATION AND TELECOMMUNICATIONS NETWORK; INC.

IDT Spectrum; LLC

MCI Communications Services; Inc

METROPOLITAN AREA NETWORKS; INC.

MPX Inc.

New Cingular Wireless PCS; LLC

Norfolk Southern Railway Company

Northrop Grumman Systems Corp.

Open Range Communications

Telecom Transport Management; Inc.

TEXAS EASTERN COMMUNICATIONS INC

Thought Transmissions LLC

Towerstream Corp.

Trex Enterprises Corporation

Westwood One Radio Networks; Inc.

With the transect list in hand, it was straightforward to step through the firms and plot their antenna locations. A Chicago to New York line-of-sight-relay would presumably be obvious, even at a glance. First on the list was “AB Services”, but the FCC website had suddenly slowed to an infuriating crawl. We waited for nearly a minute. Finally a map appeared on the screen, triggering a mixture of awe and disappointment.

A quick back of the envelope calculation indicated that even with off-the-shelf radio latencies, AB Networks, as licensed in the FCC database, was easily capable of beating Spread’s fiber. Google linked the LLC to Anton Kapela and Alex Pilosov, two gentlemen who, if nothing else, appeared to have a variety of marketable tech skills. A Wiredarticle from 2008 reported on a presentation they’d given at the DefCon hacker conference:

“…BGP eavesdropping has long been a theoretical weakness, but no one is known to have publicly demonstrated it until Anton ‘Tony’ Kapela, data center and network director at 5Nines Data, and Alex Pilosov, CEO of Pilosoft, showed their technique at the recent DefCon hacker conference. The pair successfully intercepted traffic bound for the conference network and redirected it to a system they controlled in New York before routing it back to DefCon in Las Vegas…”

Stepping through the list of licensees indicated that “Comprehensive Wireless”, “Fundamental Broadcasting” and, the creepily named “Thought Transmissions” had, starting a few months after AB’s appearance in September 2010, also licensed a network, using the different LLCs to help mask their intentions. Comprehensive-Fundamental-Thought had set up a more direct route, and if operative, would be even faster than AB’s.

*

It was clear that an arms race was developing, with an end state winner destined to be a very straight network with very fast radios. To see how far along things were, we needed to look at tick data to discern how fast the information was propagating. Was anyone already up and already front-running Spread?

The Forbes article suggested that the fiber build was spurred by a trade involving “tiny discrepancies between futures contracts in Chicago and their underlying equities in New York.” Looking through the academic literature, a paper by Joel Hasbrouck, titled “Intraday Price Formation in U.S. Equity Index Markets” jumped out by virtue of having been cited hundreds of times. The abstract reads:

“The market for U.S. equity indexes presently comprises floor-traded index futures contracts, exchange-traded funds (ETFs), electronically traded, small-denomination futures contracts (E-minis), and sector ETFs that decompose the S&P 500 index into component industry portfolios. This paper empirically investigates price discovery in this environment. For the S&P 500 and Nasdaq-100 indexes, most of the price discovery occurs in the E-mini market. For the S&P 400 MidCap index, price discovery is shared between the regular futures contract and the ETF. The S&P 500 ETF contributes markedly to price discovery in the sector ETFs, but there are only minor effects in the reverse direction.”

So it appeared that we were in familiar territory! We were effectively faced with a particle physics experiment, which was soon diagrammed on a whiteboard:

E-mini trades in Chicago propagate more than a thousand kilometers, at a substantial fraction of the speed of light, before slamming into data center “detectors” in suburban New Jersey. We could measure the latency by correlating the SPY order book response to E-mini price-changing trades. After obtaining data, sorting out FIX and ITCH, and building the order book — hassles all – we could see how fast trading was occurring.

To get a baseline, we first sifted data from the period around the end of April 2010 leading up to the Flash Crash. Those were among the now long-gone glory days of HFT. Huge volumes, huge volatility, and no sign whatsoever of anyone trading at a rate that could beat Spread, whose construction crews were racing to bore the tunnels for their fiber through the resistant Precambrian basement of the crystalline Appalachians.

Walking home that night, a Vampire Weekend song that rotated randomly into my earbuds seemed somehow apropos:

The pin-striped men of morning
Coming forward to dance
Forty million dollars
The kids don’t stand a chance

Rumors have been circulating for a while. In five minutes, at 14:00:00:00:000 exactly, these rumors will be confirmed by an official press release: McKay Brothers, the well know international low-latency provider for high-frequency trading firms, receives investment from Dutch market-making firm International Marketmakers Combination, aka IMC. One of the McKay’s mottos, “Not affiliated with any trading firm or exchange”, will have to be removed.

The press releases will state:

Under the terms of the agreement IMC will take a minority stake in McKay, providing capital for the further improvement of McKay’s networks serving the latency sensitive trading community. Financial terms of the agreement were not disclosed.

Key elements are:

• IMC makes a capital investment and acquires an equity stake • McKay maintains its independence under co-founders Stéphane Tyč and Bob Meade • McKay commits further investment to reduce latency to the physical limit in its key long haul routes • McKay continues to operate under its core business principles which include offering a level playing field and equal access to the lowest latency service for subscribers

The terms of the agreement are not disclosed and no details are provided but it seems that IMC purchased less than 30% of both McKay Brothers and their parent company Quincy Data. “That’s great news for all of the trading firms that use our networks and for the industry as a whole”, says McKay CEO Stéphane Tyč, while the Global Head of Technology at IMC, Arno de Quaasteniet, states that “as a strong, independent supplier, McKay plays a crucial role in ensuring equal and fair market access to liquidity providers. These are principles IMC shares”.

This is an interesting move. First, we may assume that IMC has been (and still is) a client of McKay Brothers. As far as I know IMC is the only Amsterdam-based trading firm that did not build a proprietary microwave network (at least in Europe), unlike Optiver and Flow Traders, the two other Dutch HFT/market-making companies. Secondly, one may ask: why McKay Brothers needed investment from a HFT firm? And why IMC? It seems like various HFT firms offered to buy McKay Brothers but the company declined. On the other hand, we may assume that the firm needed investments to improve their networks (i.e. “reducing latency to the physical limit”). Even if it’s said that McKay has the fastest network between Chicago and New Jersey, speed race is an endless war. In June 2016, Stéphane Tyč explained in Chicago that route improvements are critical to save a few microseconds, as shown in the picture below – it took four years to achieve the “route improvement” in red:

Average latencies between Chicago (CME) and New Jersey (Secaucus and Mahwah)

I don’t know how much McKay paid for the tower they acquired to save 17 microseconds between Chicago and Mahwah (the “route improvement”). That’s probably less than the €5,000,000 Jump Trading spent to purchase a tower in Houtem (Belgium), and less than what Vigilant and/or New Line Networks will spend in Richborough (if they can build these controversial very high towers). But everything is expensive and the cash flow of IMC will probably help McKay/Quincy. According to Amterdamtrader, the net profit of IMC was €185 million in 2015 (€20 million more than 2014). With all that money McKay will have the resources to acquire other towers – if needed. (If McKay builds a London-Stockholm route that would be amazing to have dishes put on old windmills.)

Now I bet McKay will have to tell the customers of their networks that they will never give IMC a speed advantage. “IMC will have no access to client information and no latency advantage”, Stéphane says.

So, one of the biggest market makers in the world (active in over 100 exchanges and employing 600 people) has stakes in one of the best low-latency networks provider in the world. It seems that the (young) HFT microwave industry is changing these days. For years you had private networks (built by proprietary firms like Vigilant/DRW, Jump, etc.) on one hand, and networks providers (McKay, Custom Connect, Perseus, etc.) on the other hands. In 2015, trading firms Jump Trading and KCG created a joint venture, New Line Networks, to “sell network bandwidth to industry participants and third party vendors”, meaning that they now compete with McKay and the other providers. Earlier this week Bloomberg reported that at least three rival trading firms (Citadel, Jump and Virtu) “are in talks to jointly build a Chicago-to-Japan communications link”, including a microwave route between Chicago and the U.S. west coast – a project dubbed “Go West”. Competition in the very low-latency area is no longer a war between proprietary trading firms and networks providers – it’s a little bit more complex now. Anyway, good luck to the brothers. Accidentally I’ll be in Amsterdam tomorrow; I’ll meet several people involved in the HFT industry and I guess what we are going to talk.

The Harvard University Campus from which the McKay, Quincy and Jefferson names come. Jefferson Microwave LLC was the first network McKay International built in the US in 2012.

I don’t watch a lot of TV (I am not a fan of TV) but two or three weeks ago I came across Le Grand Journal talk show on Canal+ – let’s say Le Grand Journal is more or less the French equivalent of the (deceased) Colbert Report or the David Letterman Show but, well, without the talent of Stephen Colbert. This kind of program is not my cup of tea but three guys (one journalist and two scientist I think) were invited to talk about artificial intelligence – the way “AI will change our world” and so on. That’s true: AI raises a lot of fascinating and ethical questions about our future and the way human beings will interact with machines, but when asked about the potential fatal consequences of artificial intelligence, the journalist responded: we already had a disaster caused by artificial intelligence, it was on May 6, 2010 and it’s called “The Flash Crash”. Wow! Both Nanex and Waddell and Reed will love this one. The SEC too.

I was really surprised because this journalist invited me to talk about my book last year (by the way, I’ll write a short post about my book as I have been asked frequently if there is an English translation of it; the answer is not… yet). He is the presenter of La Tête au Carré, which is one of the best programs about science aired by the French national channel France Inter. I remember this program very well because I was accompanied by Frédéric Abergel, who works at the laboratory of Mathematics Applied to Systems at Ecole Centrale (Paris) – some of its ex-students are now employees of HFT firms in Chicago – and previously worked for Natixis and Barclays Capital. (Frédéric is also in the organizing committee of the Paris conference Market Microstructure: Confronting Many Viewpoints where I have been invited to talk last December.) This was the first joint interview interview I gave with a quant and I remember both of us insisted on the “human side” of algorithmic trading – saying that beyond speed, algorithms are written and managed by human beings, and so on. That’s why I was very surprised to hear the journalist about AI and the Flash Crash since that was not exactly what Frédéric and I tried to explain on air – even if, recently, we learnt that hedge fund “Bridgewater Is Said to Start Artificial-Intelligence Team” but it’s not about high-frequency trading (HFT).

As this anecdote illustrates an important issue: in France (if not elsewhere) most of the press coverage of market structure and HFT is crappy (no offence, but that’s true). I understand that some HFT-related problems are complex (and I don’t pretend to get myself all these issues) but a lot of journalists don’t even try to really understand what they are talking about. One example was the “Cash Investigation” broadcast aired in June 2012 on the French national TV station France 2. Titled “Finance folle – L’attaque des robots traders” (roughly translated: “Crazy Finance – The attack of trading robots”), the 90-minute reportage was a disaster (check this AmsterdamTrader post for a fair review in English). Not only the “reportage” (big brackets are needed here) was a disaster, but the way the journalists tried to trap some interviewees was really disgusting. Jean-Philippe Bouchaud, Capital Fund Managment’s CEO, will recall it for long – the journalists tried to force him to admit CFM was a high-frequency trading firm as the company posted a job offer related to HFT; the fact is: even if CFM is colocated at one or two exchanges, these foolish journalists did not understand that a hedge fund known to take long positions needs to understand how orders are executed in the new high-frequency world. That’s quite simple, no?

In France, this pseudo TV reportage traumatized a lot of people in the financial industry (99% of the people I met since 2012 asked me: “Have you seen this terrible movie on HFT?”). The consequence of this media disaster is: no one from the industry now wants to talk to journalists about HFT anymore (and this is understandable). But a new (and more serious) French documentary about market structure and HFT is in progress. Produced by Canal+ (the main cable TV channel known to provide the best documentaries in France), it will cover the history and the recent events related to HFT. I have been contacted by the team one year ago now and I must admit they really tried to understand what they will talk about, so I accepted to be part of this project – that means: being interviewed and filmed. I am not really comfortable with that, as I don’t like TV, but I did it like I wrote my book, i.e. with a single objective: trying to explain the concrete reality of things.

I learnt interesting facts from the journalist: indeed, in France, most of the people don’t want to talk anymore because of this previous reportage that traumatized them; some people from the HFT/market industry accepted to be interviewed only because they knew I was involved – I assume they were reassured to learn that the documentary won’t be a conspiracy against HFTs and/or markets, as I told the journalist to have a balanced view of the situation; I also learnt that most of the HFT firms declined to be featured/interviewed, saying: “No, sorry, Michael Lewis’ book Flash Boys has made a lot of noise, so we are not talking” (HFTs are chickens, or what?); even the SEC said “Nope”, for the same reasons; and a big Dutch market maker has also declined. So, in France we had this terrible TV reportage, and in the US they had Flash Boys – two different products with the same consequences.

That said, as far as I know, some challenging people will appear in this 90-minute documentary due to be aired in April. Some were previously featured in other movies (Haim Bodek, Dave Lauer, Eric Hunsader and Remco Lenterman – I bet the last two won’t say the same thing); others, like IEX’s Brad Katsuyama, will appear for the first time on French TV; and apart from me, other French folks will be in too, like mathematician Mathieu Rosenbaum and McKay Brothers’ co-CEO Stéphane Tyc – you’ll see in the movie one of the McKay dish I talk about in the “HFT in my backyard” series. As for me, the interview lasted 6 hours – it was really exhausting – and the next day we moved to Houtem, where I was filmed around the Jump Trading tower, talking about my investigation on the HFT microwave networks. I tried to do my best, and that was not easy – at all. I hope all those who participated in this documentary won’t regret it.